How a 3-Year Debt Payoff Plan Takes Twelve Years

The Credit CARD Act requires credit card issuers to disclose on your monthly statement how much it will cost, and how long it will take, to pay off your credit card balance if you just make minimum payments. It’s a provision that has been applauded by consumer educators, myself included. But all is not as it seems here, and consumers who take what their statements say at face value may find themselves still stuck on the proverbial treadmill, paying faithfully each month but not getting out of debt for a very long time.

Here’s the problem.

Statements list the total balance, and how long it will take to pay off that debt if you just make the minimum payments. Below that, they list the amount you’ll have to pay each month to pay off the balance in three years. (See the example.)

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But, as three Harvard professors pointed out in a presentation before the Consumer Financial Protection Bureau:

“If someone makes no new purchases and pays exactly the 36 month number (listed on the statement each month), they will NOT get out of debt in 36 months. The 36 month amount is recalculated each month ‐ the payoff period will always be 36 months away.”

They go on to give this example: “With 15.32% APR (non‐reward rate), it will take a member with the average balance ($3900) paying her 36 month amount, followed by “minimum‐minimum” amount, 150 months to get out of debt.”

Those 150 months are a whole lot longer than 36 months!

When I saw what was happening here, it was one of those slap-myself-on-the-forehead moments. I’ve been among those who have told consumers the three-year payment amount is a great way to create a plan to get out of debt in a reasonable period of time.

But now my advice carries a big caveat.

I still think looking at the three-year payment amount on your statements is a great way to judge whether you can get out of debt on your own. Total that figure from each of your statements and then ask yourself whether you can realistically pay that amount faithfully every month for the next 36 months without charging and taking on new debt. If not, then your next step should be to seek debt help from a credit counseling agency, bankruptcy attorney and/or reputable debt settlement firm.

If, however, you total the three-year payment amounts from your statements, and realize you can afford to pay that amount each month without taking on new debt, then your next step is critical:

Stop reading that part of your statements!

You must commit to the amount shown on your statements the first month you commit to your 3-year plan. If you stick to that amount, and don’t charge anymore, you can be debt-free in 36 months. You can even set up your accounts so the payments are automatically debited from your bank or credit union account each month. (Of course, make sure the money is in your account to cover those payments when they auto debit!) This is the autopilot method. It’s simple and effective.

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But there’s an even better way.

You’ve probably already heard that paying off your highest interest rate debt first saves the most money, and that’s true. So plug the information about your debts into a rapid debt repayment calculator. It will show you how to take that same amount of money and use it to get out of debt even faster. With one of these plans, you’ll pay as much as possible on your highest rate debt first until it’s paid off, then roll your “extra” money into the second most expensive debt, and so on. Programs like DebtGoal, ReadyForZero, or Zilch, can show you how to turbocharge your debt repayment plan this way.

As for the problem with these potentially misleading figures on statements, I imagine that since this problem was presented to the Consumer Financial Protection Bureau, they are taking a look at whether better disclosures are in order. What we have now may be better than no information at all about the effect of minimum payments, but it may not be what Congress intended either

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